Trade War – To Deal or Not to Deal?

The one certainty about financial markets is that it will always be uncertain. However, events of the last nine months deserve special mention, with risk-on, risk-off, back-flips by the Federal Reserve and the seemingly daily tweet-attacks by Trump. It makes you wonder whether this is real life or a Broadway production.

The backflip by the Federal Reserve to stop hiking rates in early January had the market bouncing to a V-shape recovery from the punishment it took in the fourth quarter of 2018. Markets had discounted a US-China trade deal as imminent. However, in the past month, financial markets have been reacting to new developments in the US-China trade war that has investors second guessing as to whether both parties will come to make a deal anytime soon. For now, it seems like they are back to square one.

In a recent interview, Hamish Douglass from Magellan explained “We’ve now got a very large emerging nation who is challenging the United States for economic supremacy and military supremacy in the world, and it’s never faced a foe like this before – the Soviet Union was never an economic foe … Now they’ve actually got a foe that can challenge them economically.”

At the heart of the trade dispute is the belief that China is fighting the trade war on unfair terms. “They have been stealing intellectual property and requiring foreign companies who come to participate in their massive market to effectively transfer their intellectual capital as a cost of doing business,” Douglass says. “So, that is a very real issue and they’re trying to reset that relationship.”

China certainly has big ambitions with clear plans outlining industries they want to dominate. Those on the list includes autonomous vehicles, AI, quantum computing, 3D manufacturing, aircraft, spacecraft and several others.

“China has got very big ambitions, but the big question is: Is Trump just doing this for political purposes, or is he doing it because he really wants to reset the relationship? It appeared up until two weeks ago, it looked like it was just a deal to be done and to protect his stock market,” Douglass says.

“It’s become a little more uncertain in the past few weeks whether or not this is actually going to be resolved. We could get into a severe sort of trade war, a cold war environment, or we could actually have it settled.”

“It’s very difficult to know which way this coin is going to flip. The markets are pricing that Trump is going to do a deal with President Xi. Obviously, it’s got a little bit jittery over the past couple of weeks, but still the assessment of markets is a deal is going to be done.”

To be clear, both China and America will be hurt by the growing tariffs, with costs incurred on both sides. However, Trump may have misunderstood the impact on Americans by continually believing that China will be hurt a lot more and thereby will be forced to the table and do the deal. While China no doubt will feel the pain, Americans will also have to endure a higher cost of living and cost of doing business, especially with China. The main problem is that the politics on both sides are vastly different. China’s Xi has a lifetime to make sure China comes out stronger, but Trump may end up forcing himself into a corner with the coming 2020 election.

Our View

While the recent setback regarding the trade dispute has increased the likely short to medium term volatility of the markets, it is very difficult to predict the extent to which markets could be affected. The longer it takes to make a deal, the more uncertain markets will be which could spiral down to business and consumer confidence. These are key indicators to keep the markets moving forward. A protracted trade war could derail this growth momentum. Already, expectation on world growth has been reduced. While the market still expects a deal to be made in the next few months, there are various scenarios that must be considered and each of these outcomes carry a certain amount of probability. Due to the varying degree of risks coming out of the uncertainty, we would prefer to take a more defensive approach over the course of this year or until there are clearer signs of an end to the trade dispute.

However, our philosophy will not change, and we maintain our stance that at this market juncture, it is always important to stay with the larger and strongest investments. It is also important for all investors to reduce their long-term return expectations. We have had many years since the financial crisis where the market has delivered solid yearly returns. However, there’s strong evidence that returns over the next several years are likely to be lower than those we have experienced over the previous few years. We take the attitude that It is better to make a small return than nothing at all.

If you wish to discuss any concerns about the current market or about any strategies to do with your financial plans leading into the end of financial year, do not hesitate to call your Financial Adviser.